VAT relief on construction services: a guide
Introduction – why is it important?
One of the most important VAT reliefs for all charities, including philanthropic charities, is the ability to obtain construction services for new buildings at the zero per cent rate of VAT.
This saves charities a substantial amount of VAT which would have otherwise been charged to at the standard rate of 20%. Given the likely amounts involved, it is of paramount importance to ensure that the VAT considerations are thought of at the outset and that any potential VAT costs are known upfront.
This guide focuses on the use of non-residential buildings, as residential buildings have their own separate VAT rules. The VAT relief for the construction of new buildings requires the charity to have an intention to use the newly constructed building solely for a “relevant charitable purpose”. If they are, then the construction can be supplied at the zero per cent rate of VAT.
Many philanthropic charities would of course consider that all of their activities are charitable and therefore believe that they should qualify for the VAT relief. However, it is not always that straightforward and care must be taken to consider the relevant VAT rules in more detail before committing to any construction works.
Many philanthropists will often be asked to help fund or support capital expenditure for charities and projects that will involve the construction of new buildings. It is therefore important for them to also be aware of the relevant VAT rules in this area and any opportunities to save VAT costs.
What counts as a business activity?
It is important to remember that the VAT legislation equally applies both to charities and commercial organisations. VAT is a tax on consumption charged on goods and services, so when a charity provides goods and services for any consideration whether it is paid for in cash or in kind, this will generally be deemed to be a business activity by HMRC (not all business activities will be subject to VAT though as some will be exempt from VAT). Activities that are non-business are outside the scope of VAT, including any goods and services given away.
In order to qualify for the VAT relief, the intention must be that you will use the new commercial building solely for a “relevant charitable purpose”. In this context, this means for a non-business purpose and not as an office (i.e. you can have no business activities arising from the building). In respect of the “solely” part, HMRC accepts that 5% non-qualifying use can be allowed (based on a fair and reasonable measure of use).
HMRC’s starting point is likely to be that you are in business and have business activities if you receive any consideration for any goods or services supplied. Other factors would also have been considered, these factors are based on historic case law in this area and are based on principles established in the High Court case of CEC v Lord Fisher ( STC 238). The Fisher business tests, as they have become known, can be summarised as follows:
- Is the activity a serious undertaking earnestly pursued?
- Is the activity an occupation or function which is actively pursued with reasonable or recognisable continuity?
- Does the activity have a certain measure of substance in terms of the value of supplies made?
- Is the activity conducted in a regular manner and on sound and recognised business principles?
- Is the activity predominately concerned with the making of supplies for a consideration?
- Is it an activity that would be carried out by commercial businesses?
Many philanthropic charities may have activities that are considered to be business activities for VAT purposes without necessarily knowing. Common examples of business activities by charities include the following:
- Sponsorship income from third parties
- Website advertising / paid for banners
- Ticket sales for fund raising events
- Any paid for consulting / research projects
- Any membership subscriptions which have benefits attached
Looking at the list above it is easy for many charities to fall foul of the requirement to be solely using a building for a “relevant charitable purpose”. Care must, therefore, be taken by charities when trying to avail themselves of the VAT relief that they are able to demonstrate that their business use will not exceed 5% of the total use in order to meet the “solely” for a “relevant charitable purpose” test.
Last month the Court of Appeal released its decision in the Longridge on the Thames case (Longridge on the Thames v HMRC  EWCA Civ 930). Longridge on the Thames had paid VAT on the construction costs of a new training centre at the time but had argued that VAT should not have been charged as the construction services should have been zero-rated, and therefore had made a claim to be refunded the VAT paid.
The Court of Appeal overturned two earlier Tribunal decisions that supported Longridge on the Thames and ruled that their heavily subsidised charges for services were in fact business activities. As a result of this they did not qualify for VAT relief on the construction of the new training centre which they used to help provide water-based and other outdoor activities (for both recreational and educational purposes). Longridge on the Thames charged for these facilities, but the charge was adjusted to meet the ability of the end user to pay, insofar as donations or receipts from other activities facilitated it.
HMRC considered that the charity was carrying out business activities so that zero-rating did not apply. It argued that the Court of Justice of the EU had recently clarified the test for determining whether there was an “economic activity” or not and that this should be considered when considering the business test. Both sides accepted that a business activity for this purpose was the same as an “economic activity” under EU VAT law. HMRC claimed that this now focused on whether there was a direct link between the service which the recipient received and the payment which was made, and not on the wider context in which the payment was made and whether one of the Fisher tests was met (the charity had previously successfully argued that it was not predominately concerned with the making of supplies for a consideration).
The Court of Appeal expressly noted that a charity did not enjoy “blanket relief from VAT for its activities”’. Its liability to VAT depended on whether its activities were economic activities, judged objectively. Agreeing with HMRC, the Court of Appeal held that if there was a direct link between the service and the money received by the service provider, an economic activity was established. There was no exception for activities carried out for the benefit of the public and they must be considered to therefore be business activities for VAT purposes. Therefore the use of the new training facility could not be used solely for a “relevant charitable purpose”. This meant that they should have paid VAT at the standard rate on the costs of construction of the new training facility.
Approach by HMRC
In the past there was a perception that the charity sector was treated with a “light touch” by HMRC in respect of VAT. Unfortunately, it is clear that this is no longer the case and we have seen evidence of HMRC setting up specialist teams to target and approach charities to challenge some of the VAT treatment applied by them. This also means that where HMRC does discover an error or a situation where VAT relief has been applied incorrectly they are likely to seek penalties and interest in addition to any VAT amounts due.
The latest developments confirm that it is very difficult in many cases to draw a line between non-business activity and business activity, especially where a charity provides a service for a payment but that payment does not represent the full cost of the service. HMRC may now take a different approach to what constitutes a business activity and therefore all charities should seek to obtain advice if they are considering availing themselves of this VAT relief for construction services.
On a wider note, many charities may need to reconsider their ‘charged for’ services if they are considering carrying out construction services. The cost of the additional VAT (if they don’t qualify) is likely to far exceed the income obtained from many such charged for activities.
As a final point, it remains to be seen how Brexit will have an effect on HMRC’s approach. The Longridge on the Thames case was decided on EU law principles and so presumably, HMRC will seek to continue to apply these principles. It remains to be seen if they will be incorporated into the UK VAT law in due course.